Does Feddie Have a Future?

By

Thomas G. Donlan

Updated Aug. 21, 2010 12:01 a.m. ET

Order Reprints

Print Article

Text size

THE TREASURY DEPARTMENT and the Housing and Urban Affairs Department held a "brainstorming" session last week. Public-relations folks said the meeting in the Treasury's Cash Room was a first tentative step toward reorganizing the nation's mortgage markets. Realists said it was a half a day of organized procrastination—not much different from the two years of dawdling and talking since subprime mortgages were discovered to be subprime in fact, even when wrapped in packages labeled Triple-A.

What should be the future of "Feddie"—the collective name we give to Fannie Mae, Freddie Mac, Ginnie Mae, FHA, VA, Federal Home Loan Banks and all the other federal institutions that support home-mortgage borrowing in the U.S.? ("Feddie" is the right name for them also because the Federal Reserve created the $1.5 trillion in new credit that keeps them in business.)

Last week we heard that without Feddie, there wouldn't be a mortgage market in the U.S. That might be true: About 90% of all mortgages written this year are purchased by Fannie and Freddie, and many also carry guarantees from the Federal Housing Administration or the Veterans' Administration.

But is there a mortgage market with Feddie, or is it a middle-class welfare program disguised as a market?

The Cost of an Unfree market

According to the computations of the Congressional Budget Office, the U.S. was delivering about $280 billion to home-borrowers in the good years, including about $100 billion of foregone income tax on deductible home mortgage interest and property taxes. In bad years, like the last two and probably the next two, we must add the cost of conservatorship (loss-covering by another name) for the Feddie institutions ($148 billion and rising to an estimated $389 billion over the next 10 years), crutches for distressed homeowners (about $50 billion and rising) and rescue packages for banks seduced into lending on weak security ($350 billion and rising).

Treasury Secretary Timothy Geithner offered an accurate diagnosis, as far as it went: "The challenge is to make sure that any government guarantee is priced to cover the risk of losses, and structured to minimize taxpayer exposure," he said. "We will not support returning Fannie and Freddie to the role they played before conservatorship, where they took market share from private competitors while enjoying the perception of government support."

Total privatization, however, is not in the administration's playbook. HUD Secretary Shaun Donovan made it clear that the government will tread very carefully: "Let's remember, if we were to take rash steps, if we were to do something today that risked this market getting worse, that would be the single thing that we could do that would expose taxpayers to further losses. We have to make sure that we minimize going forward the losses to the taxpayer on those old assets that were on the books before they were taken into conservatorship."

How can Feddie minimize losses on underwater assets that haven't yet been marked to market? The losses have happened and they can't be minimized.

Take a Deep Breath

The solution the administration offers is to reinflate the housing bubble, only not so far or so fast as last time. In that direction, Fannie and Freddie soon will write mortgages for as much as 25% more than the homes are currently worth. Fannie and Freddie will do on purpose what they did before by accident.

There are other ideas: Bill Gross of Pimco, operator of giant bond funds that just happen to own massive amounts of mortgage-linked debt, told the brainstorming session that Feddie should go all in: Take over the mortgage market and refinance everybody at low rates to improve their cash flow.

The alternative, Gross said, was for private lenders to charge higher interest rates and higher fees and to extract higher down payments. For his part, he said he would not buy a mortgage-backed security without a government guarantee without being paid at least three percentage points more than current rates.

There's no difference between Gross' idea of a government's writing funny-paper mortgages and Fed Chairman Ben Bernanke's joke about stimulating the economy by throwing hundred-dollar bills out of helicopters. Especially now that we are pretty sure Bernanke was not really joking.

There's also no real difference between Gross' idea and that advanced by Rep. Barney Frank, the Massachusetts Democrat who chairs the House Financial Services Committee. After decades of defending and promoting and extending the "social mission" of Fannie and Freddie, Frank made news last week by declaring, "They should be abolished." But this was not a case of man biting dog. He quickly added, "The only question is what do you put in their place."

Frank has decided merely that Fannie and Freddie have tainted reputations, so their function must be re-invented. He has no intention of getting the government out of managing the mortgage market to keep voters happy.

Plenty of Blame

We do not blame Frank alone, or his party alone. American politicians of the left, right and middle agree that voters should be happy and secure in their homes no matter what the cost. From the New Deal to the Ownership Society, they oversold the public on the "American Dream" of home ownership.

Politicians pushed down the necessary down payment to buy a house from 20% of value realistically appraised—a normal requirement for a mortgage in 1970—to down payments of 10%, 5%, 3%, 1%, nothing and less than nothing. Values rose with easy money, turning a home mortgage from a savings plan to an instrument of speculation.

Before the government got into the mortgage business, housing was always a highly leveraged, risky investment. Typical mortgages required onerous down payments and had to be rolled over for a new interest rate every five years.

The government spent 75 years reducing the perception of risk and raising the leverage, with explosive results. We shouldn't trust the government to pick up the pieces.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.